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ISET Economist Blog

A blog about economics in the South Caucasus.

The Most Economical Economic Indicators

Measuring economic developments is often a laborious business. Consider, for example, the Consumer Price Index (CPI). One first has to define the so called consumption basket that contains the goods and services whose prices you want to track. These goods and services have to be represented in the basket in the right proportions, reflecting the consumption patterns of an average consumer. Unfortunately, consumption habits change over time, and product characteristics change even more. A personal computer 10 years ago is obviously a very different object than a new one. Would it be right then to treat an old and a new computer as the same product, just comparing the prices now and then?

No, say economists, and compute a so called Hedonic Price Index that takes into account technological advances. If a modern computer is much more powerful than an old one, but in their heydays both are sold at the same nominal price, then in fact deflation took place. Prices did not change, but computers are still much cheaper today than they were 10 years ago.

The desire to simplify, often an outgrowth of plain laziness, has driven human inventiveness throughout the ages. Economics is no exception. Certainly, economists want to do things as economical as possible. Can we measure inflation without computing the CPI?

At ISET we found the Khachapuri Index, and one can read in The Financial every week how it enables us to approximate price developments pretty well. Our index is based only on the prices of Khachapuri ingredients, and without employing a huge statistical apparatus, we get pretty good estimations of inflation rates. That is of course not to say that the statistical authority of Georgia could rely on Khachapuri prices for their inflation tracking.

There are other examples of these ingenious shortcuts taken by economists. It is an intricate issue to compare the average income of people in different countries. Unfortunately, it is not enough to just consider what people earn in their currencies, apply nominal exchange rates, and translate everything into Dollar amounts. The price levels in different countries are different, and for example one Dollar in Georgia buys much more of most goods than a Dollar in the United States. Standard economics solves this problem by calculating the so called purchasing power parity, again relying on a basket of goods and comparing their prices in different countries.

As it turns out, for a rough estimation much of this work can be saved if instead one picks one single good and compares its prices throughout the different countries of the world. Obviously, such a product must be truly equal all around the world, and making it should draw on inputs from the country where it is produced. What could it be?

The magazine The Economist found such a good: McDonald’s Big Mac. McDonalds operates in 121 countries of the world, and in each of these countries they offer Big Macs (in those places where pork meat is banned, Big Macs are made from chicken meat). So instead of finding the basked of goods and services one can buy for the same amount money in different countries, one only looks at how many Big Macs can be purchased. For fifty Dollars, for example, one can buy 30 Big Macs in India and just 8 in Sweden. Unfortunately, Georgia is not covered by this ingenious index, but one could easily calculate it by ordering a Big Mac in the next best Tbilisi McDonalds restaurant.

The showcase of economic measurement, however, is economic growth. Doing it thoroughly demands immense resources – statistical offices have to evaluate huge amounts of data that mainly come from the fiscal authorities. Because many of these data are lagged, official growth numbers may be adjusted long time after they were published for the first time. Can we find an economical solution also in this case? A possible solution will be presented on our blog on Wednesday.

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Sunday, 20 October 2019

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